Puerto Rico Tax Breaks for US Taxpayers are Real—For Now At Least

You may have heard that the US territory of Puerto Rico is offering major, legal tax breaks to US taxpayers. Sound too good to be true? You wouldn’t be the only one to wonder.

I’m here to tell you that it is true.

I moved to Puerto Rico just in time for the 2014 tax year, and saw my income tax burden reduced by a good 60%.

Now, obviously, there have to be catches. Nothing of value comes without a price. But the fact remains: investors and business owners willing to move to Puerto Rico can dramatically—and legally—reduce their tax burdens.

Act 22 is for individuals. It confers a 100% tax holiday on passive income and capital gains for 20 years. The zero tax rate covers both short-term and long-term capital gains. You have to move to Puerto Rico to qualify.

Act 20 is for companies. It gives owners of incented new Puerto Rican companies a 3–4% tax on dividended income. You have to pay yourself a normal base salary and pay normal Puerto Rican income taxes on that base salary. To qualify for Act 20, companies have to export services. (Think: consultants and call centers.) There used to be a minimum requirement of creating three Puerto Rican jobs to qualify for Act 20, then five jobs—that requirement has been reduced to zero.

The rates may go up in 2019. There is a legislative proposal in process now to raise the Act 20 rate from 4% to 10% and the Act 22 rate from 0% to 10%. Those are still low rates, but not as good as what’s available now. It is not certain these changes will become law, but the measure has already passed the house and is headed for the senate. This does not affect existing grants, but would take effect next year. Anyone seriously considering Acts 20 and 22 should act immediately. Applications approved before the end of the year should be fine. Applications submitted before the end of the year may be grandfathered.

NEWSFLASH: Just as we go to press, my sources tell me that the Puerto Rican Senate has stripped the amendment that would have raised rates for Act 20 and 22 grantees out of the bill. This attempt to reduce the benefits of the acts appears dead in the water—for now. This attempt by populist politicians to raise the rates, however, is a clear warning shot for those interested. Remember that once one has an Act 20 or 22 grant, one has a contract with the government that sets the 4% and 0% rates for 20 years. This means that changes to the acts in the future will affect new grantees, not those with grants already in hand. My Act 20 and 22 grants “grandfather” me from higher rates in the future. It’s best for anyone interested to act as soon as possible.

The key to all this is that Puerto Rican income is exempt from US federal income tax. That didn’t matter before, because Puerto Rican taxes were just as high as US taxes. But after the crash of 2008, the Puerto Rican economy never recovered, so the government offered these incentives to attract investors and entrepreneurs.

The Caveats

Keep in mind:

Only Puerto Rican income is exempt, not all income. That means that income from work by US taxpayers not done in Puerto Rico is deemed US income and is taxable by the IRS. So are dividends paid by US companies.

If you spend more than 90 days in the US, you have to spend more than half the year in Puerto Rico. You have to show that you really have become a Puerto Rican to get the IRS to recognize your exemption in an audit. If you don’t spend more than three months in the US, you’re free to travel outside of Puerto Rico as much as anyone else is.

Assume a 100% chance of being audited. These tax breaks are 100% legal. But you can’t pretend or try to stretch legal definitions and think you’ll get away with it. This is a real deal, but only for people who do it for real.

There are $5,000 filing fees, annual reports, and other paperwork. That’s a small price to pay for huge tax savings, but it’s required compliance.

There is a $5,000 charitable contribution requirement. The idea is that those receiving huge benefits from the tax breaks can and should “give back.” I could argue this, but it does help the locals to feel less resentment. This too is a small price to pay for huge tax savings.

The lowest rates may not last long. As above, the rates may change in 2019, so interested people should apply ASAP.

Puerto Rico Reality Check

Given that you really do need to live in Puerto Rico to take maximum advantage of these tax breaks, what’s it like living here? There are many pluses and minuses, of course. Here are a few:

This is a drug-war hot spot. You may read about the high crime and murder rates in Puerto Rico. They are mostly internal to the drug war. Occasionally innocent bystanders do get hit, but that’s true in New York, Los Angeles, or any large US city. Back that out, and the rest of Puerto Rico is quite peaceful.

Many real assets are selling at crisis pricing. Many gorgeous homes here sell for a fraction of what they would cost in, say, Miami.

Because this is an island subject to the US Jones Act, pretty much everything consumable is more expensive here. From gasoline to groceries, it all costs more. I understand that we have the second-most expensive electricity in the US (second only to the US Virgin Islands).

This is a survivalist’s paradise. It’s impossible to freeze here. Crops grow year-round. Better still, the average police officer here is not an arrogant jackbooted thug. The most visible ones are peace officers protecting tourists.

Driving here is like participating in a demolition derby—except that there are no rules. You’re as likely to encounter a Ferrari driving slower than you can walk as a horse cart breaking the speed limit.

One more thing that could be a plus or a minus is that while Puerto Rico is part of the US and most professionals here speak English, the primary language is Spanish. The culture is distinctly Latin. If you like salsa dancing and Caribbean food, you might love it here. If you hate cracked pavements and the occasional plastic bag floating by in the wind, you might hate it here. If hearing Spanish spoken all the time will bother you, you will be bothered quite a lot. If you always wanted to learn Spanish, this could be perfect for you.

I tell everyone who’s considering making this move that they should come and check it out. It’s not enough to spend a weekend in a fancy hotel and decide everything is nice. You need to rent a car and drive around and see what the island as a whole is like. Even if you were to live in one of the pristine gated communities, you’d still have to deal with rest of Puerto Rico.

It’s not worth it if you’d be miserable here.

What Could Go Wrong?

I have to say that there has been some pushback from people who don’t think these tax incentives are fair. I’ve never experienced the least bit of animosity from locals on the street. Even when I took a wrong turn and ended up in the “wrong” neighborhood, I never saw anything threatening or felt any danger. I have, however, seen hostile press.

On the other hand, I have met locals who “get” it and say they are happy I’m here spending money in their shops, restaurants, etc.

The harsh reality is that after Hurricane Maria caused $100 billion in damage to an already bankrupt island drowning in more than $70 billion of debt, Puerto Rico can’t afford to be too picky. I doubt one of the few sources of cash inflow the island has will be shut down any time soon.

On the other hand, if you are considering the move, you might want to make that exploratory trip happen soon. There’s a new push for Puerto Rican statehood. A bill was just introduced in Congress that could make it the 51st state by 2021.

I’m skeptical that a bankrupt territory is a good candidate for joining the union—but the sympathy generated by the devastation of Hurricane Maria could give this effort a boost.

I doubt statehood for Puerto Rico will happen anytime soon, let alone quickly, but if it does, it would likely put an end to the tax incentives. I don’t see how the other 50 states could tolerate an “equal” Puerto Rico’s exemption from the US income tax. Even if they were willing to, for a time, to help Puerto Rico recover, the Internal Revenue Code might not allow it for a state.

Regardless, Puerto Rican statehood is the biggest threat on the horizon for Acts 20 and 22.

Get Expert Advice

I should say that I’m not a tax attorney, nor an accountant. If you’re interested in making use of these incentives, however, I can connect you with people who are experts and can help you get your application in ASAP. Email me at L@LouisJamesLLC.com, and I’ll put you in touch.

Bottom Line

Personally, I didn’t move here expecting my tax breaks to last their full 20 years. I figured that five years was enough to pay for the condo. Our savings in the first year made it worth the effort. But then, we do enjoy living in the tropics.

Your mileage will vary.

Just don’t dally too long if you’re thinking this could work for you.

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